1H19 performance exceeded our expectations

Huayou Energy announced 1H19 results: revenue of 755 million yuan, up 40% year on year; net profit after tax was 75.2 million yuan, up 282% year on year, better than the profit warning issued earlier and exceeded our expectations. We believe that the performance of the first half of the year exceeded expectations mainly because the profit margin of the company's main business improved better than expected, confirming our previous view that domestic oilfield service prices are expected to rise as workload recovers.

We believe that the completed sector performed well in the first half of the year. Among them, revenue increased 115% year on year, and profit before interest, tax, depreciation, and amortization increased 225% year on year. Major performance contributions came from Tarim, Xinjiang, China, and Turkmenistan and Indonesia.

The net cash outflow from 1H19's operating activities narrowed to 48 million yuan compared to the same period last year. However, the cash used to purchase real estate, plant and equipment increased sharply to 77 million yuan. We think it was mainly due to the company's purchase of 5,000 meter deep drilling rigs to meet the demand for drilling and oil well maintenance services in the Xinjiang region.

Development trends

The Xinjiang business is expected to be a short-term catalyst. Huayou Energy continues to increase investment in the Xinjiang region, mainly due to the region's business profit level and excellent cash repayment conditions. We believe that the newly purchased drilling rig will guarantee the company's plans to expand operations in the Xinjiang region. At the same time, it is also possible to obtain more resource support by jointly establishing a joint venture with Xinjiang Energy (Group) Oil and Gas Co., Ltd. In addition, Huayou Energy plans to jointly develop a smart oilfield pilot project in the Xinjia region with AI supplier Fourth Paradigm (Beijing) Technology Co., Ltd.

Beneficiaries of the domestic shale oil and gas exploration and development boom. The company received a total contract for drilling in Changning worth 200 million yuan. We expect Huayou Energy to win more high-profit shale oil and gas projects, including horizontal drilling.

Profit forecasting and valuation

The profit forecast and target price of HK$1.00 are maintained, corresponding to 8 times the 2019 price-earnings ratio and 35% upside. The current stock price corresponds to 6 times the 2019 price-earnings ratio. Maintain an outperforming industry rating.

risks

Fluctuations in oil prices; delays in order execution.